Market participants said that dealers squaring their books ahead of an options expiration set to be the largest on record for S&P 500-linked derivatives may be helping to tamp down swings in U.S. stocks. Some $5 trillion in U.S. stock options are due to expire on Friday, with 80% in S&P 500-linked contracts – the most significant such expiration in at least 20 years – according to Asym500 MRA Institutional, a unit of derivatives strategy and execution firm Macro Risk Advisors. The move is expected to restrain volatility, potentially counterbalancing any gyrations stirred by the Federal Reserve’s monetary policy announcement on Wednesday.
While the Fed’s decision is expected to be unchanged, investors are looking for signals on whether it is ready to shift its interest-rate-hiking trajectory. Expectations for the first rate cut this year have receded from nearly 60% to 50%, according to CME’s FedWatch tool. Investors also watch for signs that the Federal Reserve can navigate an economic slowdown in Europe and Japan without raising interest rates.
However, the sluggishness in stock markets has been more complex than some commonly cited reasons, such as worries about global growth or a possible recession. A key reason is the disproportionately strong performance of five big tech companies that comprise about 11 percent of the S&P 500 index. When those “FAANG” stocks do well, they can lift the entire market. But when they do poorly, they can drag the market down.
Another factor is the positioning of dealers, who act as intermediaries between buyers and sellers of derivatives. They have accumulated a net long “gamma” position that requires them to continuously sell stock futures during equity rallies and buy them during market declines to maintain neutrality. Nomura analysts say this has been one of the main drivers of subdued trading this year.
Some observers also point to the impact of geopolitics, such as the continuing conflict involving Israel and Palestinian militants. The conflict is viewed as one of the potential triggers for a full-blown Middle East war, which could have global ramifications and lead to a recession in other parts of the world. Investors are also concerned about policy issues, such as the ongoing U.S.-China trade dispute and the prospect that a government shutdown could be on the horizon. Those concerns could add to the already high levels of anxiety in the market. They could also weigh on the Federal Reserve’s ability to tamp down volatility with a rate cut.
